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Book Review: The Mystery of Capital

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The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else
by Hernando de Soto (New York: Random House, 2000); 243 pages; $24.95.

CONSIDER THE TERM “the Third World.” Most people probably would conjure up in their minds the image of tens of millions of poverty-stricken people living in Asia, Africa, and South America possessing no means for survival other than their unskilled and primitive labor. Property ownership, in this image, is limited to a select few extremely wealthy individuals and families, who exploit others in societies so they may live lives of comfort and luxury.

Hernando de Soto, Peru’s leading free-market economist, says this image is both false and misleading. The ordinary peoples in the “undeveloped countries” of the world, in fact, have a vast amount of wealth. And this wealth enables a flourishing world of trade, commerce, industry, and employment.

Indeed, if one adds up the estimated value of real estate held by “the poor” in these countries, the total value comes to something in the neighborhood of $9.3 billion. The only problem is that most of this wealth is not in the form of legal titles to property; instead, these are “informal” ownerships not recognized or enforced by the political authorities in these parts of the world.

De Soto is the president of the Institute of Liberty and Democracy, and his team of researchers have done detailed studies of the extralegal, informal sectors in several countries. His recent book, The Mystery of Capital, summarizes their findings and offers a warning concerning the future. Among their conclusions is that in Peru, 81 percent of the rural property and 53 percent of the urban property is owned outside of the official legal order. In Egypt, 83 percent of the rural property and 92 percent of the urban property is “informally” owned. In the Philippines, 67 percent of the rural land and 57 percent of the urban land is owned informally. And in Haiti, 97 percent of the rural property and 68 percent of the urban property is owned outside the formal legal system.

Why do these properties exist beyond the system of legal titles? De Soto’s team estimated that in Peru legal authorization to build a house takes 6 years and 11 months and requires 207 administrative steps in 52 government offices, and to acquire title to the land requires an additional 728 administrative steps.

In Egypt the process takes between 6 and 11 years, involving 77 bureaucratic procedures at 31 different agencies. In the Philippines, the process takes between 13 and 25 years and requires 168 steps involving 53 agencies and offices for approval.

As a result, large segments of these societies operate outside the law. Effective ownership of property is not recorded in any of the official registries and ledger books, creating the impression of a greater degree of poverty, backwardness, and lack of entrepreneurial activity than is actually the case. De Soto concludes, “Extralegality has become the norm. The poor have already taken control of vast quantities of real estate and production.” While the informal sector serves as a dominant element enabling the people in these countries to go about the business of making a living, the system also limits the potential for growth and development.

Law and private property

The heart of de Soto’s argument is that under this informal system, a vast amount of private wealth exists as “dead capital.” Without legal title to real property — residential homes, retail businesses, factories, apartment buildings — the informal owners are unable to tap into either the national or global financial markets. Normal loans or lines of credit with real property as the collateral are difficult to acquire.How can a creditor know who owns the property, what its estimated market value might be, whom legal action could be taken against in case of failure to meet the terms of the loan agreement, and how the property title might be transferred? Instead, financial relationships are limited to the local communities in which informal customs and rules have spontaneously evolved and taken shape, in the context of which the local residents, merchants, and manufacturers recognize, respect, and even enforce property rights beyond the eye and control of the formal law of the country.

In these countries there develop two market and legal orders: the official one that duly registers and enforces property titles and the informal one that operates in a “netherworld.” De Soto refers to the legal order as a world under a “bell jar,” secure and protected and able to formally and more efficiently function. Those outside the jar in the informal sector are limited in their ability to develop and integrate themselves into the world community of commerce that offers the avenue for permanent higher standards of living.

The secret of the Western economies, he says, is that over the last 200 years Europe and North America devised the legal institutions and reforms to incorporate nearly everyone and their property into the official market. Virtually everyone in the West lives in this bell jar of secure property rights, efficient utilization of capital, and transparent financial markets to release the productive potentials of assets and their owners. As de Soto explains, in the West,

living standards rose only when governments reformed the law and the property system to facilitate the division of labor. With the ability to increase their productivity through the beneficial effects of integrated property systems, ordinary people were able to specialize in ever-widening markets and to increase capital formation.

He focuses on the American experience of the 19th century, during which local, state, and federal law slowly evolved and changed to handle the problem of “squatter’s rights” and the legal criteria for establishing both claims and titles to the land and the structures built on them. What the underdeveloped countries of the Third World need to do, de Soto insists, is to devise ways of bringing and blending together the legal and informal systems of property ownership, so that the final reformed legal order will have integrated the two. Only then, he argues, will the vast amount of private, informal wealth and entrepreneurial ability in these parts of the world be able to serve as a creative and dynamic force for transforming these areas into modern economies with standards of living equal to or even greater than those in the West.De Soto details the legal and political changes that must be implemented and how those who will be most resistant to changes in the political, legal, and social hierarchy of society may be fought.

He considers that there is not only a great need for these political and legal reforms, there is also a vital urgency in bringing them about. In spite of the end to the Cold War and the Soviet Union, the Marxist mindset still haunts the ideological and political environment in undeveloped nations.

Mistaking the interventionist and neo-mercantilist systems that predominate in these countries for free-market capitalism, collectivists of many stripes can point to the lack of opportunities for the poor, how they are outside “the system,” and how they live lives of fear that their properties will be ransomed or seized by the powerful and rich. “For those who have not noticed,” de Soto warns, “the arsenal of anti-capitalism and anti-globalization is building up.”

The poor in much of the world are locked out of formal and legal property titles to that which they already informally own, manage, and productively use. And political elites in these countries manipulate their legal systems to seize or extort the wealth of those outside of the unequal systems of privileges and monopolies.

Until Third World countries offer equal protection to all honest and peaceful property owners, the vast majority of the peoples in those lands will be easy prey to the demagogic promises and dreams of anti-market collectivists.

If real systems of market-based property rights are not established and secured around the world, de Soto warns that the coming century may turn out to be another revolt against capitalism, not because capitalism will have failed but because it will never have been fully implemented so all in these societies could benefit and have a stake in the preservation of an actual free-market order.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).